State intervention could boomerang on emerging markets

By Sebastian Tong - Analysis

LONDON (Reuters) - Confronting a global sell-off, some emerging economies are acting to prop up asset prices by resorting to trading controls and outright equity buys -- measures that could hurt their stock markets over time.

Even as regulators around the world inject extra liquidity to calm markets roiled by upheaval on Wall Street, governments in the emerging world are going a step beyond, getting closer to outright intervention.

On Thursday, Russia pledged an additional $19.59 billion to bolster its financial markets while China called on its state-owned companies to buy back their shares to help boost a bourse that has fallen more than two-thirds from last October's record peak.

Taiwan, which has directed its government funds to boost stock buying, has warned it could deploy its National Stabilization Fund to shore up its ailing equity market.

Developing economies with less sovereign wealth at their disposal have turned to price controls to staunch losses that have sunk emerging stocks to 2006 levels -- with Nigeria, Pakistan and Vietnam in recent months tightening curbs on daily share price movements.

Asia's 1997 financial crisis provoked similar market intervention by authorities, ranging from a $15 billion move by Hong Kong to ward off speculators to Malaysia's imposition of capital controls to stem foreign capital flight.

"If there are extreme situations where price distortions are great, regulators are in their power to intervene. But it's not something welcome as no one wants to invest in a manipulated market," said Nigel Rendell, emerging markets strategist at Royal Bank of Canada.

STATE BUYS

Investors say government-directed share buys -- an option only a handful of cash-rich countries can consider -- provide short-term relief but delay inevitable price corrections.

In a bearish global environment, state equity purchases allow players ideal conditions to exit from a falling market. Authorities are also left with substantial share holdings that could depress share prices when disposed of.

"Governments can come into the market to buy shares but at some point they'll have to sell and this could create an overhang, said Matthew Pearson, head of Africa equity research at Renaissance Capital.

Hong Kong, which found itself having to defend its free- market credentials after its 1998 capital markets intervention, set up its exchange-traded Tracker Fund in 2002 to help dispose of the roughly 15 percent of the free-floating shares it acquired in the Hang Seng Index.

Drawing down on government reserves for inherently risky equity purchases is seen as harmful to a country's fiscal health, reducing funds that might better be used for social or infrastructure spending.

Last week, Russia's finance minister suggested that the government may tap into its massive oil revenues to buy domestic stocks -- a proposal that drew criticism from ratings agencies Standard & Poor's and Fitch, which warned that such a move would jeopardize the country's sovereign ratings.

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